Perfect competition – the firm in the

long run
 Outline
 1. Features of the long run

 2. Long-run equilibrium of the firm

 3. Derivation of the long run supply curve

 4. Advantages & disadvantages of perfect

competition
 1. Features of the long run
 A) Existing firms are making supernormal profits
 B) All factors of production are variable
 existing firms expand

 C) Perfect factor mobility & perfect information

 new firms enter the industry (market)
 new start-ups
 switching

 Long-run equilibrium of the firm

 price, output & profit
 Fig 1a Long-run equilibrium under
perfect competition
P £
S1

Supernormal profit
LRAC
P1 AR1 D1
LRAC

D
O O

Q (millions) Q (thousands)

(a) Industry (b) Firm

 2. Long run equilibrium
 all supernormal profits competed away
 A) price is high (e.g. P11 on Figure 1a)
 B) AR > LRAC: supernormal profit
 C) industry supply expands; supply shifts right
 D) price falls (e.g. PLL on Figure 1b)
 process continues until supernormal profits are
competed away

 At PLL, QLL we have long run equilibrium

 LRAC=AC=MC=MR=AR (see Fig 2)
 Fig 1b Long-run equilibrium under perfect
competition
P £
S1
Se

LRAC
P1 AR1 D1
PL ARL DL

D
O O QL
Q (millions) Q (thousands)

(a) Industry (b) Firm

Long-run equilibrium of the firm under perfect competition
£ (SR)MC
(SR)AC

LRAC

DL
AR = MR

O Q
 3. Derivation of the long run supply curve

 Industry demand increases: what happens

to P and Q?
 initial rise in price, supernormal profits attracts new
firms
 supply increases
 If
 A) price falls back to original level, the long run supply
curve (LRS) is horizontal – constant costs
 B) price is higher than originally, the LRS is upward
sloping – increasing costs – external diseconomies
 C) price is lower than originally, LRS is downward
sloping – decreasing costs – external economies
 4. Advantages & disadvantages
 Advantages of perfect competition
 i) optimal allocation of resources
 P = MC, P=MU thus MU = MC
 (ii) competition encourages efficiency

 (iii) consumers charged a lower price

 (iv) responsive to consumer wishes: change in

demand, leads extra supply
 4. Advantages & disadvantages

 Disadvantages
 (i) insufficient profits for investment
 (ii) lack of product variety
 (iii) lack of competition over product design
and specification
 (iv) unequal distribution of goods & income
 (v) externalities e.g. pollution